Australia: Reliability requirement under the National Energy Guarantee: Proposed design up for discussion

Last Updated: 2 March 2018
Article by Dan Howard and Faith Taylor

The reliability guarantee is aimed primarily at ensuring that the supply-demand balance in the National Energy Market can be met over time.

The reliability guarantee requirement of the National Energy Guarantee consultation paper is designed to ensure that there is sufficient dispatchable generation available in the market to meet expected peak demands.

The reliability requirement will impose obligations on retailers to enter contracts directly related to dispatchable resources.

The requirement for retailers to meet these dispatchable targets by way of contract is designed to result in generation support and new generation investment to cover the existing and expected peak demand on the power system.

If retailers fail to make or fail to meet these obligations within the prescribed time, the Australian Energy Market Operator (AEMO) will be able to procure generation or demand response to close an outstanding gap.

The Energy Security Board (ESB) favour a design that is incorporated into the existing National Electricity Market (NEM) and the associated financial market structure. The ESB see the use of these existing arrangements as not requiring substantial new mechanisms or products to be developed. However, in our view existing products are likely to require modification, or new agreements will need to be developed around those existing contracts, to deliver the reliability guarantee.

Reliability not intended to deal with all system security issues

At the outset it is important to note that the reliability guarantee is not designed to directly deal with system security such as system inertia, ramping and flexibility. The Finkel review recommended consideration of a range of potential market design changes aimed at improving the security of supply including strategic reserve, a "day-ahead" market and demand response. While these system security matters are being reviewed by a range of market bodies, the reliability guarantee is aimed primarily at ensuring that the supply-demand balance in the NEM can be met over time.

Reliability Guarantee Framework - eight key steps

The ESB has proposed eight steps to establishing the reliability guarantee:

Forecasting the reliability gap

AEMO will forecast whether the reliability standard is likely to be met in any NEM region over a forecast period. This will be done by reference to peak demand.

In essence this modelling by AEMO is designed to identify if there are any expected gaps between expected capacity and forecast demand in any particular region, and the size of the gap expressed in terms of MW of additional capacity that would be required to meet the reliability standard.

It is currently anticipated that the modelling will be undertaken with a forecast horizon of two to three years although it has also been proposed that the forecast should include a 10 year horizon and industry input has been sought on this point.

How the modelling is undertaken will be critical to the success or otherwise of the reliability targets. Application of the gap forecasts to determine reliability targets has the potential to impact significantly on the nature and type of new generation and hence have a corresponding effect on new investment in renewable generation.

Updating the reliability gap

AEMO will update its forecasts so that the size of the gap can be tracked over time.

The expected outcome would be that retailers would be required to contract with generators to fill the gap so as to avoid the cost of AEMO procuring resources to close that gap.

AEMO has suggested that it could use demand response, diesel generators, batteries or other generation that would not otherwise have been in the market to cover the gap, the cost of which would be borne by the non-compliant retailers.

Triggering the requirement

Once a gap has been identified it is expected that at a relevant point in time the targets would be set such that the retailers would be required to have the relevant portion of their load covered. The aim is to have new generation supported by retail contracts, with construction of new generation (including storage) closing the gap.

Of course to do this would require corresponding generation (expected to be of the dispatchable variety) to be economically viable and commercially available for contract with retailers.

Qualifying instruments

To meet their obligations under the reliability guarantee, retailers will need to make investments, or enter into contracts that underpin new investment, in generators to fill identified gaps. The ESB is proposing that these contracts are essentially those that are available in the current market so that "no new instruments would be required".

The retail contracts will need to be certified so that there is a clear link to specific generation and MWs. In our view it is likely that we will see new or modified contracts being developed so that it is easier to identify the specific source of generation and MWh produced.

The ESB has considered restricting the type of contracts to only those that can demonstrate physical compliance such as PPAs and demand response contracts however does not favour this approach given that this could require a fundamental change to the contract market.

Stakeholders have been requested to provide their views on the types of contracts that should be considered as eligible.

The degree to which a contract is "physically backed" such that it can be certified to have met the reliability requirement broadly fall into 4 categories:

  • financial contracts (such as electricity derivatives - swaps and caps);
  • financial contracts that are certified as being reconciled back to a physical source;
  • contracts that demonstrate generation or demand response;
  • physical ownership of generation and retail.

Allocating the requirement

Rules are to be developed to allocate an identified gap to a reliability target for each retailer. This will be an important function given that penalties are proposed for not meeting the individual allocated target.

Compliance

Reporting and compliance assessment is to be carried out by the Australian Energy Regulator (AER).

Procurer of last resort

In the event that an identified gap has not be closed by a compliance date then AEMO will step in and procure sufficient cover to close the gap.

This closure may be less economically efficient and may need to rely on suboptimal plant being contracted. It is likely that the cost of closure would need to be recovered by AEMO.

Penalties

Retailers that do not meet their target obligations will be subject to penalties. The precise nature of those penalties is not yet known. One proposal is that the cost of closing the gap be allocated to the particular retailers that have failed to meet their reliability requirements. This cost could be in addition to a penalty for failing to meet the obligation.

Emissions-intensive trade exposed business (EITE)

The reliability guarantee will cover all forms of demand. This means that EITE demand will not simply be removed from the reliability guarantee. It is expected that EITE will be obliged to ensure that they have contracts in place which cover dispatchable generation sufficient to cover supply during peak demand or contracts that cover demand response.

RELATED KNOWLEDGE

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

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